Mutual Funds and Your Financial Plan

Hi everyone, and welcome back to Melissa Making Cents!

As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, one of the many functions I like to fulfill with this blog is education. While many in the general population are familiar with financial terms like stocks, bonds, etc., they also lack an understanding of what those terms actually mean. Because of this, I’ve created a series of posts that are dedicated to brushing up our knowledge and bringing more awareness to terms like these. If you’re interested, you can check out some more posts that I have recently written: Stocks and Your Financial Plan; Bonds and Your Financial Plan. 

Today we’re going to be talking about a subject that’s actually very interesting and eye-opening to many investors… Mutual Funds! Nerd Wallet defines a mutual fund as “…an investment that pools money from investors to purchase stocks, bonds and other assets.”. That might not make a lot of sense just yet, but keep reading, and it’ll come together quickly!

Remember that any investment has it's risks and rewards. Before you  make an investment talk to a financial professional to make sure that the investment aligns with your personal financial goals and needs.  This blog post is for information only and is not meant to be a recommendation. 

How a Mutual Fund Functions

A mutual fund is essentially two things! It’s both an investment and an investment strategy. It’s sort of difficult to pin down between the two because to the investor/consumer of the mutual fund, it’s essentially a bulk investment that they have with a bank, financial professional, or financial institution. However, there’s quite a bit that goes on behind the scenes with mutual funds. To the person or team managing a mutual fund, it’s a conglomeration of investments being driven by an overarching investment strategy. 

To put things into simply terms... a mutual fund is a pool of money that purchased a basket of investments to pursue an objective that is stated by the mutual fund company. 

Why a Mutual Fund Instead of a Single Investment?

There are a few reasons why one might choose to invest in a mutual fund instead of pooling all of their money into a single investment. For starters, the best part about mutual funds is the fact that they’re diversified. Diversification is, in essence, when you invest in varying businesses and industries. For example, if you were to invest in oil and gas, you may also wish to diversify your investments by also investing in electric vehicle companies. Diversifying not only avoids putting all of your eggs in one basket but also acts as a theoretical see-saw.

Opposed to a mutual fund, a single investment has no counter-balance. For example, if you’re exclusively invested in the oil and gas industry, you’re betting that it’ll do well, and you hopefully won’t take any hits. To further our example, if the oil industry takes a hit, the electric car industry may do well. This counter-balance acts to keep your investments steady and hopefully continue earning even when some of your assets aren’t doing so hot. Diversity in your mutual fund, or portfolio, can balance the losses of some investments with the gains of others. 

Advantages of Mutual Funds

There are many advantages to mutual funds, which is one reason that they’re so popular! Diving into these will help us understand more about them and describe the value that they bring to the table!

• Relatively Safe 

While no investment is 100% certain or free of risk, mutual funds do something extraordinary! The beauty of mutual funds (and diversification in general) is that they mitigate risk. In other words, they take a large amount of risk that you take on with one investment and spread it out over multiple assets. This means that you’re less likely to lose a large portion of the value of your investments in one fell swoop because of a single investment misstep. Investors who are more risk-averse tend to really appreciate the mitigation of risk that a mutual fund brings to the table!

• Diversification

Along with relative safety, the diversification of a mutual fund creates the possibility of creating more wealth! Being invested in multiple businesses and industries allows you to both spread risk and reward. In other words, the more eggs in the basket, the more likely one of them will hatch!

• Steady Growth

The balance of diversity creates a more steady growth rate. Instead of watching and hoping that one investment will go up, you’re watching the overall health of your mutual fund portfolio. Mitigation of risks and rewards means that while you won’t make as much with each individual investment, the health of your portfolio is more likely to steadily rise as long as your portfolio is well managed.

• Varying Objectives

As of 2020, there were 7,943 different mutual funds registered in the United States and approximately 126,500 thousand different funds globally! Each fund has different investment objectives, as well as fees and availability.  Therefore, if one fund doesn't work for you... there are lots of other options!

Disadvantages of Mutual Funds

Like any investment, mutual funds aren’t immune to risks or drawbacks. Unfortunately, there are some, and you should be aware of them to make a better-informed decision about what type of investing strategy is right for you. 

• Costs

There are fees associated with creating and managing a mutual fund, and those must be paid by the investor  As with any investment managed by someone else, you must compensate the manager for their time and expertise. Fees like these make up the expense ratios and may vary depending on who’s managing your mutual fund. Mutual Funds fees and expenses are normally subtracted from the fund's gross returns, and not paid out of pocket.

• Over-Diversification

While diversification is a beautiful thing, over-diversification can negatively impact your financial earnings with mutual funds. This concept is just what it sounds like. Over-diversification is spreading your investments out too much and too thin. In other words, you’re putting too little money into too many companies. This can be avoided by having someone skilled in financial practice manage your investment portfolio.

• Inconsistent Returns

While they’re great, mutual fund’s returns won’t always be the same. There are little to no guarantees in the financial world! This is true for many investments, which is why it’s also valid for mutual funds. If you consider that a mutual fund is essentially a conglomeration of stocks, bonds, and other investments, it makes sense.

A CERTIFIED FINANCIAL PLANNER™ Can Help You Manage Your Investment Portfolio

If you’re managing your own investment portfolio, you may find it very difficult to predict what will happen in the market. This ambiguity makes it even more challenging to balance your investments accordingly with your financial goals. Properly utilizing a financial planner, like myself, takes a lot of the guesswork out of the equation and allows you to focus your attention elsewhere. 

If you’d like to learn more about mutual funds or if you’d like to begin investing, please, feel free to call or email to schedule an appointment with me. Together we can create a financial plan that helps you make the most out of your money and investments. 

Until next time...this is Melissa Making Cents!

Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.